DUBAI, Sept 26 (Reuters) - The long-drawn-out political deadlock between Kuwait's cabinet and parliament has hurt the stock market, but fund managers and analysts believe government-linked funds may have stepped in to support shares, and blue chips are reaping the benefit.

The market's index slumped to an eight-year low in mid-August, underperforming most other stock markets in the Gulf, largely because of the political situation.

Opposition legislators are boycotting parliament and accuse the government of trying to gerrymander voting districts for the next election, which could be held by the end of this year. In the meantime, much economic policy-making and many investment plans have been frozen.

But in the last several weeks the index has partially recovered and it now stands at a three-month high, 5 percent above its trough. It is 2.3 percent higher than its level at the end of last year.

Many in the market suspect government-linked funds are buying stocks. Speculation centres on the Kuwait Investment Authority (KIA), the country's sovereign wealth fund in which much of its oil wealth is parked, and on other funds in which the government owns stakes.

The apparent intervention suggests there may be little further risk in Kuwaiti stocks even if the political situation remains grim. But it also implies any further rally of the market could fizzle out if authorities decide they have bought enough shares.

"Most of the talk in the market is that KIA has started the buying spree through its portfolios located with investment companies in Kuwait," said Fouad Abdulrahman Alhadlaq, deputy general manager at Al Dar Asset Management.

ASSETS

The government has not publicly announced any intervention in the market, and KIA officials were not available to comment on the fund's activities. The KIA's orders are generally placed confidentially among the brokers which serve it.

But intervention would fit in with past policy patterns in Kuwait. During the global credit crisis of 2008, the Kuwaiti government asked the KIA to set up a long-term fund to invest in the local bourse. The government also offered to buy up assets from investment firms hit by the crisis.

The KIA would almost certainly have enough cash to conduct fresh intervention. Although the size of its overseas and domestic assets is secret, it is believed by analysts to exceed $300 billion. High oil prices are allowing the government to run a big budget surplus, ensuring additional inflows into the KIA.

Intervention might serve at least three purposes. It would limit stock market losses suffered by Kuwaiti investment firms, some of which are still recovering from the 2008 crisis. It would let the government avoid being blamed for a politically embarrassing market slide that could hurt tens of thousands of individual investors who will vote in the next elections.

And if Kuwaiti stocks rebound in the long term after political tensions eventually ease, the government could end up making a profit on its purchases.

"The KIA supports the market when it is oversold and valuations are attractive," said Jasem al-Zeraei, head of institutional sales at NBK Capital.

The extent to which the stock market's tone has improved can be seen in trading turnover, which surged to 425 million shares on Wednesday, more than double the average of 186 million over the past 50 days.

Alhadlaq At Al Dar Asset Management said the KIA was believed to be buying shares of blue chip companies in which it already held stakes.

However, analysts noted there was room for disappointment among investors if the speculation about government intervention turned out to be misplaced.

And with opposition legislators demanding fundamental political reforms that would involve giving parliament more power in relation to the cabinet, it is not clear that the next elections will stabilise politics.

"Sentiment remains weary. Fundamentally, nothing has changed and we're learning to live with these circumstances," NBK's Zeraei said.